Consumer Psyche is Economic Key

Even something as number-centric as economic forecasting cant account for the most important factor in what it predicts: how consumers feel about their pocketbooks, about the national economy, about life in general. Thats why its so difficult for economists and the people who depend on them to draw a bead on where the U.S. economy may be headed over the next several months. And its the reason there remain highly divergent views of what direction that might be  backward into a double-dip recession, or a continued, if erratic, path upward.

Unless things do get a lot worse, well probably muddle through this, said Nariman Behravesh, chief economist for IHS Global Insight, a Lexington, Mass.based economic-research firm. It shared similarly optimistic views with its clientele worldwide in a Thursday, March 24 conference call in the wake of the earthquake and tsunami in Japan, and amid violence in the Middle East. Well take a hit to growth of a few tenths of a percentage point. But in its current form, neither of these shocks is going to be a recovery killer.

The conventional scenario at this point is the American economy is at the beginning of what will be a pronounced, prolonged and progressive recovery after three years in the dumps of the Great Recession. And in this view, so far, nothing that has been thrown at us  also including persistently high unemployment and gasoline-price increases  has gained a potency that can derail this trend.

And In This CornerOn the other hand, there persists a different, darker perspective. In this picture, most American consumers remain dazed by their experiences during the downturn, perhaps permanently seared in the way their forebears were by the Great Depression  more value-oriented than ever, more interested for the first time in saving than in spending. We want to believe in a brighter economic future again but are afraid to embrace the hope, this evaluation says. This recovery is just a dead-cat bounce, said David Littmann, a veteran banking-sector economist in Michigan who believes another economic slowdown is ahead. And thats what kills consumer confidence.

In this view, when new hammer blows come along such as gasoline prices pushing $4 a gallon, and a once-a-millennium natural disaster and threats of nuclear meltdown in Japan, and conflagration in Libya that could spread to its oil-rich neighbors  well, nows the time to pull in our horns financially, because the new uncertainties are adding ponderous weight on top of the gnawing old ones.

We ask open-ended questions about what people talk about around the dinner table, said Britt Beemer, chairman and founder of Americas Research Group, a Summerville, S.C.based firm that regularly polls and interviews consumers. And to my amazement, what were hearing nowadays is people worried about whether their kids will be able to find a good job  and were talking years from now. Ive never seen answers like this before.

Up for GrabsLacey Plache, chief economist for Edmunds.com, said one reason these views cant be reconciled is so much has happened very recently that hasnt been fully absorbed yet  not by consumers or by economists. Its kind of wait-and-see for now, she said. We dont have the full picture. Things are still developing.

For the automotive sector, recovery momentum seems to have continued at least through this month. March sales should hold up as savvy consumers buy in advance of any pricing changes that might result from production disruptions due to mayhem in Japan, Jeremy Anwyl, CEO of Edmunds.com, wrote recently. April is when we will get a real indication of how the consumer is holding up.

The conventional view remains tipped toward optimism that the U.S. economy can weather the current storms and American consumers will continue to warm up to their own prospects, if only gradually. I think weve gone through a big spasm of over-reaction to news from Japan and Libya, and now were kind of getting things back into perspective, said Dana Johnson, chief economist for Comerica Bank. The net of it all is that the overall scenario of an entrenched, increasing private-sector recovery in the U.S. is holding up pretty well.

Behravesh conceded growth in the U.S. over the next few years will be closer to 3 percent a year than the 3.5 percent the firm had forecast until recently. But thats still a pretty decent number. he said. The U.S. economy will be firing on more cylinders in 2011, [as] the impact from Japans disaster and higher oil prices will be limited.

Digging DeeperHeres a factor-by-factor look at what economists are trying to digest right now about the economic picture, particularly as it affects the consumer psyche:

The Usual NumbersOn paper, a lot of things are going right for the U.S. economy that werent even a quarter ago. Weve got more hiring and spending and production this year than last, and the auto sector will be stronger, Johnson said. Unemployment finally has begun easing down. As a result, consumer spending has risen for the past few months. Behravesh said net exports also would contribute more to U.S. growth.

What Were ThinkingCompany executives and owners are growing convinced the recovery is real. Business optimism, Behravesh said, is the highest in three years, and cash flow remains very strong. Even about 56 percent of small-business owners, the much-celebrated economic backbone of America, expect the economy to improve further, according to a new survey by Office Depot, and about 70 percent forecast jumps in both their own sales and profits.

But on the consumer level, the indicators tend to be disturbing. Nearly every significant reading on American consumer confidence has ticked down lately. For example, Gallups weekly reading for the week ended March 20 was its worst of 2011 and in line with that of a year ago. In addition to reflecting current events, such readings stem from a fundamental economic anxiety many Americans still have about the future. Only 21 percent of the people we poll are seeing anybody at work get overtime, Beemer said. So they know there wont be any hiring in their business.

At The PumpNo factor dictates Americans basic evaluations of whether the economy is headed in the right direction as much as gasoline prices, said Sean McAlinden, chief economist of the Center for Automotive Research. Since the 1970s, every major economic downturn in America has been caused by an upward spike in oil prices, said Mark Zupan, dean of the business school at the University of Rochester, in New York. Even in 2008, the core problem was obviously the bubble in the housing market  but it didnt really get exposed until high oil prices put a brake on the economy.

This happens for two reasons. First, gyrating oil prices remind Americans at a disturbingly visceral level of our dependence for an essential economic commodity on a number of unstable  including some very hostile  nations. Its a region of the world that has been problematic to U.S. interests and which few in this country really understand.

On a more financially immediate basis, the problem with fast-rising gasoline prices is Americans must repeat the purchase regularly, often more than once a week. And whatever extra amount the pump demands, theyve got to pay  theres little flexibility to get away from it, especially in the short term. Its so fundamental, Littmann said. Its everything, and its ubiquitous, and in terms of spending it is psychologically devastating.

And as consumers try to squeeze by, stress builds. People tend not to change their budgets or spending patterns dramatically  they just pay more for gas, or food if its that, and go on with the rest of their spending too, observed Srinivas Thiruvadanthai, director of research for the Jerome Levy Forecasting Center, an economics think tank in Mt. Cisco, N.Y. And then if it persists for a while, people start running up their credit-card balances.

Except, perhaps, this time around. Beemer said Americans may react more precipitately to higher gasoline prices now than before because more are living in a cash environment in which theyre trying to refrain from credit purchases. If youre trying to stick to that, and now you put $25 more into your gas tank than you did before, it has a greater immediate impact because you have $25 less to spend right away, Beemer said. Whereas, two years ago your charge card would just have $25 more on it.

The New NormalBeemer said such cash-oriented behavior is more than anecdotal. Americas Research Groups latest survey showed a record-breaking 71 percent of respondents were trying to stay away from credit cards.

And that is just one indicator a new, more parsimonious attitude has taken hold in many American households  what some analysts have taken to calling the new normal. Whether they have lost jobs, or lost income, or seen their 401(k)s sacked, or sacrificed pensions, or just know a lot of other people who have, these people are still clutching their wallets despite signs of a building recovery and brighter economic future.

Theres been lots of speculation whether Americans would loosen up a bit financially once it became clear a recovery was under way. And the fact that consumer spending is inching up would seem to suggest the answer is yes.

Yet a fundamental new conservatism persists. In the sixth Harris Poll since 2009 to ask about 12 steps consumers might take to save money and avoid spending too much, the results were virtually identical to those from six months ago. Almost the same proportions of adults report, for example, they are purchasing more generic brands, brown-bagging their lunches, and switching to refillable water bottles.

House And HomeMaybe even more corrosive than the employment situation is what has happened to U.S. housing markets and values. They continue to bump along an ever-lowering bottom. Sales of new homes fell by nearly 17 percent in February from January, for instance, delivering a shock to analysts who had expected a gain. Median sale prices fell by nearly 14 percent, which represents the sharpest one-month drop on record.

Beemers surveys see the unease this creates from another angle: Sixty-four percent, in the most recent one, reported vacant homes in their neighborhoods. To them, he said, that means theyll have no equity in their homes. And if their kids are in junior high, theyll have to find another means of putting their kids through college.

And Still LoomingSome economists believe more Americans share a fundamental fear about our long-term prospects. As citizens, they sense a loss of national control  now that China is selling off a bunch of U.S. debt, will other countries follow? As taxpayers, theyre tired of worrying about the ever-ballooning federal deficit. The dollar continues to lose value but the Fed keeps printing more. Wont these systemic problems eventually cause inflation unlike weve ever known before? A lot of things are playing a role in how people feel about this, Beemer said. And none of them are any good.